Preparation GMAC

To prevent or to prepare? It’s a question you probably ask yourself a lot more than you realize. In relationships, business, and even our health we often have to decide if it is better to try to prevent something from happening than it is to prepare for it (or vice versa). Charles De Gaulle once said we should all make use of the inevitable. He was a preparer and an expert survivor. He was also French and a real asshole.

Chuck, however, was able to secure French participation in the division of Germany post World War II, avoid having American troops stationed in France, and even develop advanced nuclear power and weapons capability largely without American or British help. In short, he led France out of a horrible period of war and despair into a period of independence and abundance without having to give up much. De Gaulle had the insight that France would be better off understanding and adapting to post war change than trying to prevent that change from altering the country(1).

Unfortunately the US Treasury Department does not share De Gaulle’s philosophy. On December 30th the Treasury Department announced a $3.8 billion capital infusion into General Motors Acceptance Corporation (GMAC) extending it’s ownership of the one time General Motor’s division to 56%. The intent is to "protect taxpayers and put GMAC in a position to raise private capital and pay back taxpayers as soon as practicable," announced the Treasury. The reason the government feels the need to ‘protect’ taxpayers is because it already shelled out $12.5 billion to keep GMAC solvent. From a tax payer perspective it’s a lot like betting the over/under to make up for a loss if the Colts don’t cover against the Bills. A strategy traditionally referred to as throwing good money after bad.

So what the hell does this have to do with my prevent or prepare question three paragraph’s ago? The Treasury is trying to prevent GMAC from biting the big one when it may be cheaper and less risky to put a bullet in it. Here’s my reasoning, or more accurately put my rant: A free market should allow for the destruction of participants that can not survive through self generated value. This assumes it is more costly and risky trying to prevent such a loss than to prepare for it. We’ve seen above how the U.S. Treasury is trying to prevent the loss of a major financial player under the assumption that its demise would negatively impact auto and home lending. Could it be cheaper and less risky if we prepared for it? I vote yes.

Here’s how preparation makes more sense than prevention. First, allow GMAC to go bankrupt. I’m not talking about bankruptcy light like chapter 11. No, no, I’m talking lucky 7; liquidation. The good loans would find a home and the bad loans would be written off. The argument against liquidation is that there would be less lending bandwidth for cars and houses and would thus impact economic growth. That’s not a bad thing because too much lending got us into the current mess.

Another part of the preparation would be to insure loans properly, as savings accounts are today, so that defaults would be covered. This approach is somewhat robbing Peter to pay Paul in that higher interest rates are the preferred mechanism to protect against defaults. However, adding default insurance could be better for consumers and lenders by offering more appropriate pricing.

In short, we can prepare for economic tsunamis by constantly adding taxpayer bricks to the seawall or we can pick our beachside property more carefully and put our houses on pilings. We can fall prey to the hubris of believing we can control complex events and systems or we can recognize the inevitable and make use of it.

Later


(1) Shady note: Isn’t it interesting how France is viewed today as being regressive and insular? Another De Gaulle quote “I have tried to lift France out of the mud. But she will return to her errors and vomitings. I cannot prevent the French from being French.”